Article What Are the Different Strategies for EMU Countries?

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1 econstor Der Open-Access-Publikationsserver der ZBW Leibniz-Informationszentrum Wirtschaft The Open Access Publication Server of the ZBW Leibniz Information Centre for Economics Artus, Patrick Article What Are the Different Strategies for EMU Countries? Vierteljahrshefte zur Wirtschaftsforschung Provided in Cooperation with: German Institute for Economic Research (DIW Berlin) Suggested Citation: Artus, Patrick (6) : What Are the Different Strategies for EMU Countries?, Vierteljahrshefte zur Wirtschaftsforschung, ISSN , Duncker & Humblot, Berlin, Vol. 75, Iss. 2, pp , This Version is available at: Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. zbw Leibniz-Informationszentrum Wirtschaft Leibniz Information Centre for Economics

2 Vierteljahrshefte zur Wirtschaftsforschung 75 (6), 2, S What Are the Different Strategies for EMU Countries? By Patrick Artus* The answer to competition from emerging countries with low wage costs must be very different according to the affected sector. We need to draw a distinction between manufacturing industry and services that can be relocated and other sectors: consumer services, retail, construction, most business services and financial services. For the former, no obstacle to restructuring or the modernisation of companies can be efficient, even though this implies further relocations and job losses. For the latter, there is a crucial need to analyse and assess the various experiments that seek to stimulate job creation in said sectors, as this is indispensable if industry is to continue losing jobs. We complete the analysis of the strategy of the various countries in manufacturing by a research of the determinants of exports performance. 1 The Exchange Rate Is no longer a Useful Instrument against Emerging Countries The question consists in determining the best response for EMU countries to competition from emerging countries with low wage costs, in Asia and Central Europe, which, moreover, practise tax and welfare competition. Let us start off from the fact that this response cannot be provided by exchange rates: on the one hand, emerging countries have avoided an appreciation in their currencies, by currency interventions in Asia (central bank reserves in Asia increase by more than 3 bns $ a year) on the other hand, the size of the required adjustments to equalize the extremely different producer costs between advanced countries and emerging countries, would be so considerable the Chinese Renminbi would need to appreciate 5% to 7% that such adjustments are unrealistic. 2 One Must Differentiate between Sectors Facing International Competition and Sheltered Sectors The strategy of EMU countries can be absolutely different with regard to the sectors facing international competition from emerging countries, i. e. manufacturing industry and business services, and the sectors sheltered from international competition: consumer services, retail, construction, etc. In the sectors facing international competition for the sake of simplicity, we will say industry the answer has to consist in cost-cutting and product differentiation, in compari- * Chief Economist of Ixis Corporate and Investment Bank (Groupe Caisse d'epargne) and Caisse des Dépôts, Member of the council of Economic Advisors to the French government, Professor at Ecole Polytechnique and at the University Paris I Panthéon Sorbonne, partus@ixis-cib.com DIW Berlin 65

3 Patrick Artus son with the goods manufactured by emerging countries. Success then lies, first, in the capacity to lower unit costs as can be seen in, Japan and Sweden, but not at all in the Netherlands, Spain and Italy; while and the United States are in an intermediate situation (Figures 1 and 2). In advanced countries, lowering unit costs is achieved to a greater extent by substantial productivity gains, as is the case in,, the United States (due to IT industry), Sweden and Japan than by reducing wages - although there is downward pressure on wages in and Japan: in, normal wages per head stagnate since 3, In Japan, since the early 199s. Figure 1 Unit Wage in Manufacturing Sector (1996 = ) Italy Spain Figure 2 Unit Wage in Manufacturing Sector (1996 = ) 11 United States Japan Sweden Netherlands Source: Datastream IXIS CIB. 66 DIW Berlin

4 What Are the Different Strategies for EMU Countries? It also consists in offshoring, i.e. accelerating subcontracting in countries with low wage costs, as can be seen in the decline in the share of added value in production in most European countries. Moreover, success has to be achieved via the capacity to innovate, and develop different products. As is well known, corporate R&D expenditure and the efficiency of R&D are high in the United States, Japan, the Nordic countries and ; but are low in and even more in the countries of southern Europe (Tables 1a, 1b and 1c). Among the major countries, the winners from this industrial point of view are, for example,, Japan and the Nordic countries in Europe, as is seen in trends in foreign trade (Figures 3 and 4) and its contribution to growth; the losers, for instance, include the United States,, Italy and Spain. In real terms, the United States, and Italy post more or less the same level of exports in 5 as in late. Table 1a Corporate R&D (in % of GDP) Spain Italy United States Sweden Japan Sources: OECD, Eurostat. Table 1b Number of Corporate Researchers (per 1,) Spain Italy United States Sweden Japan n/a n/a Sources: Science, technology and industry: OECD Outlook 2 4. Table 1c Number of Triadic Patents (per million inhabitants) Spain Italy United States Sweden Japan Source: Table n 65 Main Science and Technology Indicators 4, OECD. DIW Berlin 67

5 Patrick Artus Figure 3 Exports (in volume terms, 1996 = ) United States Japan Sweden Netherlands Source: Datastream IXIS CIB. Figure 4 Exports (in volume terms, 1996 = ) Italy Spain Source: Datastream IXIS CIB. We will return later to the analysis of the causes of the divergence between the export performances of, and Italy. Industrial success inevitably implies job losses in manufacturing, if there are substantial productivity gains in industry, and outsourcing. The countries that are winning export market shares, i. e., Sweden and Japan, however, are countries where industrial employment is contracting by 1% in Sweden, 12% in Japan and in since the start of this decade. Industrial success can therefore generate income, if exports enjoy ro- 68 DIW Berlin

6 What Are the Different Strategies for EMU Countries? bust growth, for instance, but it cannot provide full employment. The unemployment rate is not lower in Sweden or (9%) than in other countries where export market shares are contracting (Italy: 7%, Spain: 8%, for instance). Full employment, by consequence, can only result from job creation in the sheltered sectors we will say services for the sake of simplicity. 3 How to Create Jobs in Services? Potentially, there are two possible reasons why job creation is weakened in services in many Continental European countries:, and Italy, for example. One is found in the excessive low-skill labour costs, either in terms of direct wage or mandatory welfare contributions; the other is the existence of labour market regulations that are unfavourable for job creation. The two causes of the shortfall in jobs in services are simultaneous; as is well known, if there were as many per capita jobs in services (understood as sectors not facing international competition ) in, for example, as in the United States, there would be 2.5 million jobs more in. Another well-known fact is that the minimum wage is close to 5% of the average wage in, versus 3% of the average wage in the United States and this has played a role in the sluggish job creation for unskilled labour in. Which problem has to be solved first? A comparison of the economic policies recently implemented in and Italy is very interesting from this viewpoint. In, due to the different employment contracts with lower remuneration one-euro jobs, mini-jobs and Ich-AGs the approach based on reducing labour costs has been implemented. The real wage and purchasing power of wage earners have declined since 1, in an impressive way recentry ( 2% year over year for the real wage per head in ). In Italy, with employment contracts providing lower job protection introduced in the early s for the categories of labour suffering from a high unemployment rate, the approach based on deregulating the labour market has been chosen, without a significant squeezing of payroll costs. Currently, the outcome suggests Italy s choice is better: employment has grown 12% between 1998 and 5, and 17% outside industry. In Italy, the unemployment rate has sharply declined (from 11,5% in 1999 to just above 7% in the first half of 6), while in, even though the labour market has stabilized the squeezing of wages has led to a contraction in domestic demand and real activity. The ideal would obviously be, for a country, to be able as in (Figure 5) and Japan to win back market shares in manufacturing (which entails lowering unit costs and a drive to boost innovation and product differentiation) as well as create a lot of jobs in services, as is the case in Spain and, to a smaller degree, in the United States. Employment in services has increased by % over the last 1 years in the US, by 6% (!) in Spain. This would enable the country to renew with full employment despite the inevitable losses of industrial jobs, due to productivity gains, outsourcing, etc. DIW Berlin 69

7 Patrick Artus Figure 5 Ratio of Country Exports (in % of total exports) United States Japan Sweden Netherlands Sources: DRI, IXIS CIB. This requires channelling government expenditures into applications that favour innovation, drawing public and private research closer; accepting job losses in manufacturing and outsourcing as well as doing away with regulatory obstacles in the way of job creation in services. No European country has managed to do so to date: and Italy have been losing export market shares since the late 199s, Spain holds very small market shares; is not creating jobs in services while the Netherlands has been losing jobs in services from 2 to the middle of 4. Such changes will not occur in Italy and Spain, where the handicap with respect to producer costs in industry is too serious to be corrected. Among major European countries, might be able to adapt, as Italy s example shows that the so-called New Hire Contract could be a success and where public credits for research (National Research Agency, competitiveness hubs, etc.) are increasing, as could, if the approach based on reducing wages is dropped to the benefit of the approach drawing on the flexibility of employment contracts. 4 An Analysis of the Causes of the Divergence in Export Performances between, and Italy 4.1 A Deterioration of Foreign Trade in and Italy Let us have another look at the problem of success in manufacturing industry. Figure 6 shows that, since early 1, and above all between 2 and 5, Italian and French exports have grown at a far slower pace than German exports and world trade. Such a situation did not prevail between 1997 and for. All in all, the contribution of foreign trade to growth is negative and has been increasingly negative in since 2, while on average it has been positive in. In both exports and imports and have grown at a brisk pace and there is a substantial trade surplus, probably 3 bn dollars in 6. 7 DIW Berlin

8 What Are the Different Strategies for EMU Countries? Figure 6 Exports by Country and Global Trade (real % Y/Y) Italy Global trade Source: Datastream IXIS CIB. In, exports and imports have also surged, while a large trade deficit appeared in 4, with energy a crucial component of this deficit but the rest of trade deteriorating as well: the trade surplus ex energy has sunk to a very low level. In Italy, trade surpluses have vanished as has the surplus in the trade balance ex energy. The deterioration in s foreign trade primarily appears with the euro zone, Central Europe and China. A surplus is recorded with the EU-15 ex the euro zone and the United States. The situation is exactly the same in Italy. With respect to, apart from the deficit in energy, there have been more worrisome developments: the agrifood surplus has stagnated, substantial deficits have appeared in consumer goods and intermediate goods, the surplus has disappeared and been replaced by a deficit for capital goods and transport equipment. Italy posts a deficit in the agrifood sector, energy naturally, and intermediate goods. The Italian surplus in consumer goods has shrunk but the country still posts a surplus in capital goods and transport equipment. In and in Italy, growth has lagged behind with regard to the level of exports of capital goods and transport equipment as well as exports shipped to emerging countries (Figures 7 and 8). This is an interesting observation: German exporters are in a position to react rapidly to sharp increases in the demand for imported products in fast growing countries, which is not the case for French and Italian exporters, and reveals the inertia of supply in and Italy. Overall, the relative situations of and Italy have deteriorated significantly versus with respect to export performance since the late 199s although the situ- DIW Berlin 71

9 Patrick Artus Figure 7 Exports to China and Hong Kong (USD bn per year) Italy Source: Datastream IXIS CIB, IMF. Figure 8 Exports to CEEC and Russia (USD bn per year) 6 4 Italy Source: Datastream IXIS CIB, IMF. ation is slightly less serious in Italy because of its performance in the field of capital goods. If we consider these developments in a long-term perspective, nevertheless, has made noteworthy efforts to adapt to international competition. From 197 to 1999, s market share in the global trade of industrial and agricultural goods excluding commodities, for instance, declined by only 4 points, versus 15 points for or the United States. 72 DIW Berlin

10 What Are the Different Strategies for EMU Countries? In, the divergence in and Italy s performance when compared with became unfavourable. From this year onwards, the French and Italian economies apparently lost ground with respect to the new conditions of globalisation, whereas the German economy, despite price-competitiveness problems, adapted more efficiently. s relative global market share, in comparison with and Italy, renewed with its longrun average in the early s. 4.2 The Problem Does Not Result from the Geographical Destinations or from the Structure by Major Groups of Products of French Exports We will now focus more specifically on the case of. When we compare the geographical structure of exports, we can see that the EU accounts for a smaller share in, and a larger share is held by the United States, Asia and especially Central Europe (Tables 2a and 2b). When we compare the structure by major groups of products, clearly capital goods and transport equipment are far more substantial in (Table 3). Against the context of very robust growth in emerging countries, and therefore substantial investment, by definition the fact that a country holds a large or a small position in the global market of capital goods is not neutral. Unfortunately, in this sector, s weight is negligible: it posts a surplus of.3% of the global market, i.e. more than ten times less than. Table 2a Geographical Structure of French s Exports (in % of total exports) 4 Euro zone EU ex euro zone Japan 1.6 Canada.73 Mexico.45 United States 6.91 Africa 5.49 South America (non-oecd) 1.35 Latin America (including Mexico) Middle East (non-oecd) 3.15 Far East (non-oecd) 4.88 o/w China 1.61 Asian emerging countries 2 ex China 2.87 CEEC Other 9.25 Total. 1 Colombia, Mexico, Brazil, Argentina, Venezuela, Chile, Peru, and Ecuador. 2 South Korea, Indonesia, Malaysia, Singapore, Philippines, Thailand, and Hong Kong. 3 Czech Republic, Hungary, Poland, Slovak Republic and Baltic countries. Sources: Monthly international trade data, OECD. DIW Berlin 73

11 Patrick Artus Table 2b Geographical Structure of German s Exports (in % of total exports) 4 Euro zone 43.5 EU ex euro zone 12.3 Japan 1.73 Canada.66 Mexico.67 United States 8.83 Africa 1.85 South America (non-oecd) 1.36 Latin America (including Mexico) Middle East (non-oecd) 2.31 Far East (non-oecd) 6.4 o/w China 2.86 Asian emerging countries 2 ex China 3.5 CEEC Other Total. 1 Colombia, Mexico, Brazil, Argentina, Venezuela, Chile, Peru, and Ecuador. 2 South Korea, Indonesia, Malaysia, Singapore, Philippines, Thailand, and Hong Kong. 3 Czech Republic, Hungary, Poland, Slovak Republic and Baltic countries. Sources: Monthly international trade data, OECD. Consumer goods are another important sectoral issue. China and now the emerging countries taken as a whole currently have a dominant position with respect to these goods. The Chinese surplus represents 8% of the corresponding global market (2). It has doubled in ten years. China overtook Japan in this sector in the mid-199s. Emerging countries overtook Japan in. While the share held by Italy and is negligible, s position has been growing. We can gauge the effect on export performance of these divergences in sectoral and geographical structures between and. Table 3 Exports by Product in and (4, in % of total exports) 1: Agriculture and food : Intermediate goods : Energy : Consumer goods : Capital goods and transport equipment Total.. Source: OECD monthly foreign trade data. 74 DIW Berlin

12 What Are the Different Strategies for EMU Countries? Doing so shows us that both structure effects are unimportant in terms of explaining s underperformance (Table 4). Table 4 Growth Gap in French and German Exports (1998 3, in %) Contribution of the sectoral structure effect to the total gap 9.2 Contribution of the geographical structure effect to the total gap 6.4 Source: Conseil d Analyse Economique,. 4.3 Has Declined in Comparison with for nearly all Products and in nearly all Markets One can also calculate the contribution made by various sectors to the explanation of s underperformance in terms of export growth in comparison with. The sectoral performance effect is very unfavourable for for the four following sectors: Radio, television and communication equipment Office material and Information Technology equipment Aerospace Automobile Taken as a whole, these four sectors account for nearly 6% of the performance effect. Only two sectors curtail s sectoral outperformance: i.e. Pharmaceuticals and, to a smaller extent, Iron and Steel. We can thus definitely see that the performance effect is favourable for quite generally speaking and is found in most sectors, specially, in cars, machines, equipment If one breaks down the French underperformance versus by zone, one finds that: Bilateral trade is the export market that explains s underperformance versus to the greatest extent, as it contributes 23.8% to the French underperformance: the geographical performance effect between and is accounted for by the fact that growth in German exports to far outpaces growth in French exports to. This results probably from the fact that domestic demand is more robust in than in. 47% of this underperformance is explained by Europe ex bilateral trade (and including Switzerland); 27% of this underperformance comes from the Asia and Oceania zone, as defined in Table 5, in the following order: China, South Korea and Thailand; DIW Berlin 75

13 Patrick Artus to a lesser extent, 12% of the negative geographical performance effect for is explained by the better performance of German exports to the United States; conversely, a significant surprise from this breakdown is found in the outperformance of French exports to the CEEC: indeed, with respect to this zone, posts export growth rates that are overall higher in the period, and this enables to offset the negative effect resulting from the underperformances described above. 4.4 The Reasons Accounting for and Italy s Market Share Losses: Specialisation in Low Quality Products and Shortfall in Outsourcing Complementary information is provided by CEPII s BACI database. The detailed data about international trade covering all exporters are collected at product level (about 5, products). The data allow us to calculate at a sophisticated level exporters positioning in terms of range, for each product. We can then aggregate our findings within sectors or within overall trade in order to ascertain whether countries are specialised, generally speaking, in different product range segments within sectors, while taking into account the fact that their specialisation between sectors is less different than commonly thought, apart from the weight of capital goods in. It can immediately be seen that is specialised in upmarket products (Figure 9), in the medium- and upmarket range and Italy in the low and medium range. These specialisation aspects entail differences in pricing power for the producers of the three countries, and these differences imply differentiated reactions to a same exchange rate shock. In other words, the quality of French and Italian products is declining. is specialising in low quality products and is less and less specialised in high quality products. We must also look at outsourcing, a crucial characteristic of the bazaar economy. The concept of the bazaar economy primarily consists of the idea that such an economy becomes a re-exporting platform, with specialisation in assembling and marketing. Against this backdrop, ever fewer goods are manufactured locally. According to the partisans of this concept, the economy is then characterised by: growing imports of intermediate goods in connection with foreign direct investment (FDI), a fall in the weight of added value in production, the low content in jobs of exports, sluggishness of demand resulting from both the impact of employment on consumption and of the substitution of FDI for domestic investment, an acceleration in de-industrialisation and a rise in unemployment. 76 DIW Berlin

14 What Are the Different Strategies for EMU Countries? Figure 9 Breakdown by Quality of Exports of Good, and Italy (2, in %) Italy Low Medium High Source: CEPII-BACI. The ratio between value added and production in manufacturing industries is a good indicator of outsourcing. This ratio has dropped 6 percentage points in since 197, and the decline, apart from the fluctuations that followed the oil shocks, really began in the second half of the eighties. Furthermore, the pace at which the ratio has fallen has been markedly gathering momentum since Figure 1 Penetration Rate of Imports Manufactured Goods Strong Increase in despite Sluggish Demand (in %) Italy Sources: STAN, IXIS CIB. DIW Berlin 77

15 Patrick Artus Italy has experienced a quite similar decline, while in the deterioration has been more gradual and, all in all, less significant, in particular since the early nineties. Figure 1 provides information that tends to add credence to the idea that the German economy, more affected than the economies other countries, is heading towards becoming a bazaar economy. We can see that, unlike, has insourced : the share of imported intermediate consumption has increased in total intermediate consumption where exports have contracted. The fact that outsourcing has developed far more in than in while German exports are more sensitive to outsourcing can explain an estimated 6% to 75% of the gap in terms of export growth between the two countries. 5 Summary 1. French and Italian foreign trade has deteriorated significantly since 1; 2. The problem does not stem from the geographical structure or the structure by major groups of products of French and Italian exports; 3. has lost ground on for nearly all products and in nearly all markets; 4. The causes of French and Italian market share losses are the insufficient specialisation in high quality products and the shortfall in outsourcing to emerging countries. The problem is durable and the solution entails reinvesting in quality and accepting the initial costs (in added value and jobs) of outsourcing. 78 DIW Berlin